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FIN 501 (31)
Chapter 8

CFIN501- Chapter 8- Stock Price Behavior and Market Efficiency.docx

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FIN 501
Edward Blinder

CFIN501 Chapter 8 Stock Price Behavior and Market EfficiencyIntroduction To Market EfficiencyEfficient markets hypothesis EMHpractical matter investors cannot consistently beat the MarketWhat Does Beat The Market MeanExpect riskier investments to have larger returns than less risky assetsInvestments appear to have a high or low return doesnt tell us muchoNeed to know if the return was high or low relative to the risk involvedExcess returnreturn in excess of that earned by other investment having the same riskoDetermine if an investment is superior to anotherPositive investment has outperformed other investments of the same riskoConsistently earning a positive excess return beating the marketFoundations Of Market EfficiencyEconomic forces can leas to market efficientoInvestor rationalityoIndependent deviations from rationalityoArbitrageConditions are so powerfulany of them can result in market efficiencyRational investors do not systematically overvalue or undervalue financial assets in light of the information that they possessoNo bargains would be heldrelative process would all be correctRationality conditions does not holdmarket could still be efficientoIrrationalitynoise that is diversified awayoIndependent deviations from rationality markets still may be efficientIrrational traderscollective irrationality does not balance outoObserved market prices can be too high or too low relative to their riskArbitragebuying relatively inexpensive stocks and selling relatively expensive stocksRational arbitrage traders dominate irrational tradersmarket will still be efficientForms of Market EfficiencyMarket is efficient with respect to some particular information if that information is not useful in earning a positive excess returnThree general type of information weak semistrong and strongParticular sets of information used in the 3 forms of market efficiency are nestedoInformation set in strong form includes the information set in the semistrong formoIncludes information set in the weak formWeak form efficient marketinformation reflected in past prices and volume figures is of no value in beating the marketoTechnical analysisusing past prices and volume to predict future pricesNo use in weak form Semistrongpublicly available information of any and all kinds is of no use in beating the marketoFundamental analysis techniques are uselessoPast price and volume data are publicly available informationoAlso weak form efficientStrongno information of any kind public or private is useful in beating the marketoMarket is strong form efficient it is necessarily weak and semistrong form efficient as welloIgnoring issue of legalitypossession of nonpublic inside information od may types would clearly enable you to earn essentially unlimited returnWhy Would A Market Be EfficientDriving force towards market efficiencycompetition and profit motiveMost advance information processing tools availableinvestors and security analysts constantly appraise stock values buying stocks even slightly undervalued and selling those that look even slightly overvaluedConstant appraisal and subsequent trading activity act to ensure that prices never differ much from their efficient market priceRelativity small performance enhancements are worth tremendous amounts of moneycreate incentive to unearth relevant information and use it1
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